Morning Commentary: Tip of the Iceberg

Foreign Exchange - Morning Commentary
Tip of the Iceberg 
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Economic data continues to improve as economies re-open, companies bring back furloughed workers and consumers return from lockdowns.  As with other parts of the economy, the labor market has bounced back from its extreme collapse in April.  To this end, the government’s most recent jobs report showed employment increasing by 2.5 million jobs and the hope is that June’s report continues this positive momentum.  

However, there are still reasons to remain cautious.  While the latest jobs report was wildly positive relative to expectations, ~90% of the jobs lost in April and May have yet to be recovered.  Moreover, it is likely that government support has played a large role in the labor market recovery.  

Adding up all of the various government support programs shows that 29% of the labor force was aided by some sort of enhanced government program in May.  This is important because most of the PPP funds have been spent and enhanced unemployment benefits are scheduled to return to normal at the end of July.  This suggests that a labor market adjustment could be imminent unless these benefits are extended or there is a surge in labor demand.   

Related to this is the possibility that layoffs could be becoming more permanent.  Early in the crisis, many companies laid off workers with the assumption that these workers would be rehired after the lockdown ended.  Yet initial jobless claims continue to run at 2.5 times the peak rate during the Great Recession.  This could be a sign that businesses are either preparing for an extended period of below normal activity or are going out of business.  

Forecasting has always been a tricky task and the large cross currents in the markets makes this truer than ever.  Current market consensus calls for 3.2 million jobs to be added at the government’s next jobs report.  However, with so many variables, including a drop in employment as PPP funds runs out, high volatility around economic data series is expected.  This means that it is important to look beyond the direct virus shock and also consider second round impacts being told by variable such as elevated initial jobless claims. 
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • Risk sentiment took a tumble on reports that the US is considering tariffs on $3.1 billion of exports from France, Germany, Spain and the UK.  US tariff action would likely be a mix of new tariffs and increases in existing tariffs with new duties as high as 100%.  Adding to the market headwinds is the possibility of “carousel retaliation” where a country periodically shifts tariffs on different groups of goods.  This strategy maximizes pain by creating elevated uncertainty and hitting as many industries as possible.  The US’ action is related to a WTO ruling on the ongoing US-EU fight over aircraft subsidies, for which the WTO has said both sides engaged in.  To this end, the WTO is expected to authorize a similar retaliation for the EU in a separate but related case.  
  • Virus headlines have turned negative with COVID-19 cases surging in Texas, Florida, Arizona and California as officials consider slowing or reversing reopening plans.  Unlike in other countries where infection rates have peaked and tapered, the US is holding at a worryingly high level.  In the UK, a large group of health experts have warned, via an open letter to the government, on a second wave of infections.  Looking ahead, the re-opening process will be a balance of economic gain with deteriorating health outcomes with the former now favored over the latter.  Clearly if the infection rate gets bad enough, there will be further lockdowns, but the bar for that appears to be much higher than it previously was.  
  • The IMF cut its outlook for the world economy and now sees a deeper recession and slower recovery than two months ago.  Global GDP is now expected to shrink 4.9% versus the previous estimate for a 3.0% decline.  
  • The US could be in line for another round of stimulus with Treasury Secretary Mnuchin indicating it could be passed by July.  However with markets recovering from their extreme lows, support for further stimulus remains mixed.  To this end, details from the Bank of Japan’s latest meeting suggest that while policymakers stand ready to act, the emergency response to the pandemic is over.  
  • Germany’s IFO business climate survey came in better than expected at 86.2 versus expectations for an 85.0 print.  Elsewhere, Austria issued its second 100-year bond.  
  • In central bank action, the RBNZ and the Bank of Thailand both held rates unchanged as expected.  Conversely, Hungary’s central bank surprised markets with a 15 bps cut.  
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